Five Things to Remember about Hobby Income and Expenses

Many taxpayers enjoy hobbies that are also a source of income. A taxpayer must report taxable income on their tax returns even if it is generated from a hobby. I have handled many hobby versus business issues, both when I was an IRS litigation attorney and on the private practice side of the proceedings. They are fact intensive cases and require a seasoned tax professional who is familiar with internal procedure as much as the law. This blog touches on reporting tips to keep you out of trouble.

The Hobby Rules for how to report the income and expenses depend on whether the activity is a hobby or a business. There are special rules and limits for deductions taxpayers can claim for hobbies. Here are five things to consider:

1. Determine if the activity is a business or a hobby. If someone has a business, they operate the business to make a profit. In contrast, people engage in a hobby for sport or recreation, not to make a profit. There is a nine factor checklist that should be addressed when determining whether an activity is a “business” or a “hobby.” Again, the facts of the activity determines the character. The government will argue form over substance when a taxpayer attempts to mask a hobby activity in “business clothing.”
2. Allowable hobby deductions. Taxpayers can usually deduct ordinary and necessary hobby expenses within certain limits: a. Ordinary expense is common and accepted for the activity. b. Necessary expense is appropriate for the activity.
3. Limits on hobby expenses. Taxpayers can generally only deduct hobby expenses up to the amount of hobby income. If hobby expenses are more than its income, taxpayers have a loss from the activity. However, a hobby loss can’t be deducted from other income.
4. How to deduct hobby expenses. Taxpayers must itemize deductions on their tax return to deduct hobby expenses. Expenses may fall into three types of deductions, and special rules apply to each type. You claim hobby expenses on Schedule A, Itemized Deductions.
5. Call your tax attorney! The Hobby Rules are complex and hazardous unless you clearly understand them. When in doubt, it’s better to call than risk an audit, and the IRS loves to argue about hobby vs. business activities.